Professional Documents
Culture Documents
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As challenges and opportunities for growth are defined, options to defend, grow, fix or exit can be
assessed and prioritised based on the companys goals, capabilities and financial position. Generally,
companies can choose from a myriad of strategic objectives such as:
profitable growth to increase business breadth or depth through revenue growth, market share
capture, margin enhancement or improved asset utilisation;
skill strengthening to acquire the necessary talent to remain competitive (e.g. personnel, technology,
capability, geographies, etc.);
portfolio management to manage a portfolio of businesses in order to maximise existing and
evolving capabilities, reduce risk, or reposition a business;
defensive action to ward off potential take-over attempts or fix existing business/operational problems;
opportunistic posture to capitalise on a unique market/competitive opportunity or a developing
business formula; and
globalisation to expand market share and sales in international venues.
Depending on a companys strategy, acquisitions may serve as a way to quickly achieve strategic and
financial objectives.
6.2 Target sourcing and selection
Once the company has determined that an acquisition fits with its wider corporate strategy, the next
phase is to identify potential targets, synergy opportunities and to arrive at a valuation.
Developing a pool of targets
In assessing investment opportunities, a company should evaluate the attractiveness of the sector in
which it plans to conduct an acquisition by:
nnderstanding the industry structure and leverage points, where value can be captured;
appreciating the market scale, and growth potentials;
understanding the key players, both domestic and foreign-owned, along with competitive dynamics;
envisaging any technological trend; and
identifying entry barriers.
Once the decision is made to pursue opportunities in a sector, the company can begin its preliminary
research on potential acquisition candidates.
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shareholding preferences i.e. determining the desired level of control over the target and defining a
criteria for either a majority or a minority shareholding;
transaction structure preferences i.e. acquisition of shares against assets; and
management requirements i.e. taking into consideration leadership style, expertise, receptivity to
change, compatibility of culture, and modality of management after the completion of the
transaction.
(ii) Operational
marketing criteria: product lines, customer base, brand reputation, geographic area, distribution
channels;
research & development requirements: e.g. licences, patents, research & development centres, product
pipeline, research & development expenses; and
production criteria, such as facilities, labour supply, production techniques and capacity.
Short-listed targets should be further screened to determine:
their fit into the buyers current business portfolio;
their competitive position and future prospects; and
the value they create for the buyer.
(iii) Collecting target data
Availability of target data in the UK is generally good. UK companies have to file publicly available
financial statements on an annual basis. These must be audited wherever a company exceeds certain
size limits. For listed or quoted companies, more regular reporting is required and information may be
available from investment analyst coverage.
(iv) Prioritising targets
Buyers should prioritise potential targets according to the number of screening criteria the target
companies fulfil. This is also an opportunity to establish under what circumstances the company would
walk away from one target and move on to the next.
Prior to approaching the target company, additional research and information gathering should be
conducted by a financial advisor to provide a more complete picture of the candidate. This would
include information on ownership and management teams in the target companies, and include
subjective elements such as family situations and succession plans (e.g. the willingness of children to
take over the business). Very often, negotiation levers are identified during this process.
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economies of scale: Increased purchasing power, e.g. improved pricing on contract services;
expenditure avoidance: For instance, avoiding the expense of new distributor relationships or the
duplication of existing capacities such as IT systems;
operational efficiency: Increasing your control of processes, e.g. maintenance scheduling;
practices adoption: Using technology from the target company, i.e. technology transfer;
organisational streamlining: Reducing organisational layers and breadth, e.g. spans of control,
substitution of external/internal sources; and
performance realignment: Considering more efficient structures, e.g. centralising certain departments
or outsourcing.
Functions
Opportunities
Information Technology
Customer Relationship
Management
Product Development
Tax
Human Capital
Valuation
Identifying and reviewing synergy opportunities is critical to determining whether a candidate company
should be further considered as an acquisition target. Selecting the appropriate target will enhance the
performance of the buyer after integrating the entity.
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6.3 Valuation
Determining the value of the target to the acquiring company is clearly a key part of the M&A process.
The valuation should enable the buyer to avoid paying more than the target is worth.
(i) Financial modelling
Building a financial model is an essential step towards accurate valuation of the target. By going deep
into the targets financials, buyers will be able to make well-informed decisions by assessing its real
growth potential and associated risks.
Buyers should compile three elements from the target financials: an income statement, a balance sheet
and a cashflow statement with historical, current, and forecasted figures. Forecasted figures should
cover at least five years and include three scenarios with different sets of assumptions:
most likely;
most pessimistic; and
most optimistic.
All too often, people take a binary view, either they underestimate uncertainty or they overestimate it
and go with their gut instinct. Building three different models (base, good and bad cases) will help to
come up with reasonably satisfying forecasts by spreading the risks and adopting a disciplined method.
It is not easy to compose a great financial model. This is largely because the focus is often on inputting
figures rather than appreciating the underlying factors. As seen in the diagram below, buyers have to
challenge their financial model with at least four major factors that are critical to the success of every
new venture: the people, the opportunity, the context, and the possibilities for both risks and rewards.
Context
Buyers
Financial
Model
People
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Deriving forecasts when they are not available remains a hard exercise, particularly if the potential target
is out of a companys core sector(s). To build a suitable financial model requires buyers to raise the
necessary questions, make critical assumptions, and develop an in-depth understanding of the context in
which the target operates, for example, is the market rapidly growing? Is the industry structurally active?
(ii) Valuation approaches
Three approaches are commonly used in the valuation of a company. The first approach uses the future
cashflow of the company, the second examines market comparables, and the third analyses the balance
sheet to arrive at a fair value of net assets. Combinations of these approaches may be used to obtain an
appropriate range of fair market value.
Discounted cashflow
Income approach
Market comparison
Discount rate
Growth rate
Terminal value
Margin improvement
Price/earnings
Price/revenues
Price/net worth
Enterprise value/EBITDA
Enterprise value/EBIT
The above valuation methodologies aim to determine the fair market value, although that sum may not
represent the final transaction price. Valuation is an art. While the use of formulas in a valuation implies
exactness, it is very difficult to set the worth of a company at a single figure.
To establish a market value, hard figures such as historical earnings, cashflow, assets and liabilities are
used. But soft or subjective figures such as projected earnings, future cashflow, and the value of
intangibles (e.g. patents, brands, expertise and leases at below-market rate) are also considered.
The deal environment may influence the final transaction price; factors such as the current market
conditions, industry popularity, acquisition structure, tax attributes, and the objectives of the seller or
buyer often have an impact on pricing.
Indeed, the final transaction price is largely influenced by the eagerness of the buyer to buy and the
seller to sell, the demand and supply for targets, the form of consideration paid (e.g. shares, cash) and
the negotiation skills of the parties.
6.4 Executing the deal: The diligence process
Having determined that M&A is consistent with the corporate strategy, identified and valued the target,
the deal must then be executed. At this stage, identification of key issues within the target business can
make the difference between a successful deal at the right price and an expensive failure.
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Operational due diligence is increasingly being used by corporations and private equity firms to help
identify operational risks and/or opportunities in a target. Typical operational risks might include
separating a division from its parent company or the successful delivery of a planned operational
restructuring/performance improvement initiative, which often support forecast EBIT growth (Earnings
Before Interest and Tax). Operational opportunities identified during a due diligence typically include cost
synergies from the post merger integration, or the identification of potential opportunities to deliver
performance improvement/cost reduction within the target.
The targets operations are assessed for their ability to support the forecast assumptions that underpin
the targets valuation: outputs, costs, quality, delivery, cost savings, management structure and
capabilities. The diligence can then be refined and enhanced as access to the target and further
information become available.
Considering pension costs
Many UK companies operate large staff pension plans which have built up substantial liabilities over the
years. Assets are held by these pension plans in order to meet these liabilities. However, the amount of
assets held is often insufficient, giving rise to a deficit in the pension plan. This is the legal responsibility
of the sponsoring company.
Pension deficits and the contributions required to meet them are a big issue in UK transactions. A strong
Pensions Regulator and the powers of the Trustees who run the pension plan mean negotiations with
these additional parties are often required during a transaction to agree upon cash contributions or
alternative security for the Trustees. Early consideration of pension issues in a UK transaction is important
to avoid shocks later in the process.
Company accounting disclosures for pension plans in the UK appear full and informative. However, the
mortality tables used are often out of date and other assumptions can be optimistic relative to the
Trustees viewpoint. High proportions of equity assets also mean the financial positions of plans are
volatile. This means comprehensive pensions due diligence is an essential item in a UK transaction
process.
6.5 Executing the deal
Deal structuring
A buyer should generally structure the transaction by taking into account the needs expressed by the
seller as well as their own requirements. There are many ways to structure and specify terms for a
transaction. Essential to formulating the optimal transaction structure, the buyer (with the assistance of
a financial advisor) should:
conduct a scenario analysis on different possible transactional structures;
evaluate the financial impact on the company for each scenario; and
identify and determine the appropriate deal structure.
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A buyer can either buy the shares from existing shareholders or directly acquire the assets from the
target company. Acquiring shares tends to be more popular than acquiring assets because:
all shareholders of the acquired entity will share the risks of the merger;
an asset acquisition may require consent from third parties not directly involved in the transaction; and
tax considerations (see section Tax Structuring below).
In addition to the financial structure of the deal, buyers may also consider management, assets, tax and
financing issues, in order to structure the transaction in a way that suits all parties involved.
(i) Continuity in management
The continued employment of management is often subject to considerable negotiation. A buyer often
considers the management team as a key asset in an acquisition, particularly if the buyer is a financial
investor. Under such circumstances, employment agreements are often negotiated with key people,
specifying terms, responsibilities, remuneration, and equity participation. Buyers should recognise that
retaining existing management would provide continuity in business operations while slowing down
cultural integration.
(ii) Consideration
The consideration a prospective buyer can offer may be in the form of cash, notes, stocks, shareholders
loans, or a combination of the above. Since each form of consideration has different implications and
liquidity, the transaction price may be subject to further negotiation depending on the form of
consideration offered. The two most common forms of consideration are cash and stock. Figure 11
summarises the characteristics of each.
Key characteristics
Cash
Stock
A less liquid financial instrument, particularly if the companys shares are not publicly traded,
or is not liquid enough for a small cap stock.
A less liquid financial instrument, particularly if the companys shares are not publicly traded,
or is not liquid enough for a small cap stock.
Increased complexity as there is a need to determine both the buyers share value and the
targets fair market value.
The seller will share benefits and risks of the transaction by:
assuming the risk that the buyers shares are over-valued;
taking benefit of future synergies.
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Advice on integrating the target into any existing group (which often results in ideas for a postacquisition 100 day plan), for example a review of the new groups transfer pricing policies, tax
efficient supply chain management, cash pooling and group treasury functions, planning around
intangible assets (egg intellectual property), effective tax consolidation, opportunities for tax credits
(egg research & development credits available in many countries) and key compliance/tax risk
management features of the new structure.
Advice regarding financing the acquisition tax efficiently, including issuing stock as consideration to
sellers and/or taking on third party acquisition debt. Where there are third party lenders, they
sometimes require reports (common where the buyers are financial buyers) to satisfy themselves that
the structure is tax efficient (egg effective tax relief for interest on acquisition debt) and that there are
no restrictions to their debt being serviced.
Mitigating acquisition costs, including VAT on transaction costs, tax deductibility of transaction costs,
transfer taxes (shares & real estate) and capital duty.
Anticipated exit strategies and sales of non-core businesses. Often, a clients strategy includes selling
off non-core businesses in the target group in the months following an acquisition. Setting up an
acquisition structure that is flexible to achieve a range of possible exit scenarios is a crucial part of the
advice. Many European jurisdictions have tax exemptions for sales of subsidiaries in certain
circumstances, so planning upfront can often result in non-core businesses being sold tax efficiently
(often tax-free).
On multi-jurisdictional transactions (egg for European groups), taking responsibility for integrating
advice from tax advisers across multiple jurisdictions to ensure that the end product is complete and
covers all of the areas necessary.
Overall, tax considerations must be integrated into other areas of the deal. For example, all of the above
structuring has to be achievable within the legal framework of the jurisdictions involved, so ensuring
that tax and legal advisers work closely together enables a complete and workable solution, as opposed
to one that works for tax but which is not capable of being implemented for legal reasons.
Financing
(i) Optimising the targets finances
The level of investment that needs to be made in working capital for UK businesses varies tremendously
between different sectors. This is driven by a combination of the nature of the product and its supply
chain, the commercial norms in the sector, and the power balance between a business and its
customers and suppliers.
Payment terms are part of the commercial arrangements between companies; although negotiations are
often based on sector standards and practice as opposed to legislation. There is however legislation in
place to claim interest on late payments with small businesses having the additional benefit of being
able to challenge grossly unfair contract terms.
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There are a number of payment methods employed, ranging from cash to electronic fund transfer.
Direct debit payments have become widely used which give a higher level of assurance that payments
will be made on time for the correct amount.
Larger businesses are increasingly using shared services or outsourcing to manage the administration of
payables and receivables in their business. These operations tend to be situated offshore, although some
are being moved back to the UK.
It is relatively common practice for companies to have a year end push on working capital to ensure that
the reported numbers are looking as favourable as possible. This will typically involve chasing customer
payments through phone calls and delaying supplier payments until the following month.
(ii) Raising debt to finance the deal
The banking market in the UK is large and well developed. The most dominant participants in lending to
businesses are generally banks which have a large high-street presence and a strong retail deposit base.
Corporate banking departments provide companies with the full range of banking services and are
relationship led. Many banks have dedicated acquisition finance functions which support the active
private equity industry, providing debt finance for leveraged buy-outs. In larger transactions, debt
finance will be led by an arranging bank or banks that will subsequently syndicate the debt to a group
of participating banks. The UK financial markets are amongst the most sophisticated in the world.
As such, they support the issuance and secondary trading of a wide variety of debt instruments, in
addition to traditional bank debt such as bonds, convertible bonds, private placements and interest rate
and foreign currency hedging instruments.
Negotiations and the role of the lead advisor
The lead advisor plays a key role in the negotiation process. In addition to managing the many
professional advisors involved, including legal advisors, accountants, tax advisors and valuers, the advisor
provides negotiation support throughout the deal execution. In supporting the buyer, an experienced
lead advisor will generally help to understand and evaluate risks, advise on deal structuring techniques
as a competitive advantage, consider the maximum purchase price that can be paid for the target, and
compare the premium with the expected value creation to maximise shareholder value.
During negotiations, the lead advisor generally should support a buyer by:
developing the initial strategy to be applied to kick off the negotiation process;
mapping the sequence of steps to be used in the negotiations;
advising on the transaction details proposed and counter-proposed;
developing responses to counter-offers made by counter-parties.
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Integration
approach
Status quo
Take-over/Reverse take-over
Best of both
Level of
integration
Low.
Medium.
High.
Level of synergy
potential
Low.
Medium.
High.
Level of risk to
be managed
Medium.
High.
High.
Pros
Effective at capturing
near-term synergies.
Cons
Requires coordination
processes for overlapping,
market-facing areas.
Capturing synergies
Synergy capture should preferably be analysed early in the integration process to build momentum and
credibility amongst employees, investors and analysts. A prioritisation exercise should be performed
with the initial focus on the high-end, quick-hit projects because these generate the greatest
momentum. For each individual, synergy-capturing project, the integration team should develop a plan
with detailed tasks, milestones, dates and accountability so that expected results can be monitored and
achieved.
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Talent retention
(i) Understanding the people issues
Buying a business brings many challenges from a people perspective. These vary from understanding the
pay, benefits and grading structure of the target business, to integrating the new people.
During the transaction process, it is essential that employees of both target and acquirer feel they are
being kept informed. Regular communication from management is important, which can be done by
written or web-based materials, and/or employee presentations.
It is important to consider the structure of the new business from a people perspective, both in terms of
organisation and structure, and also where people will fit and what their rewards will be. This will help
to retain and lock in key people, ensuring they are motivated and aligned to the goals of the new
organisation. If this is not done successfully, then the business risks losing its key staff and thereby
potentially risks losing its ability to deliver the anticipated benefits of the acquisition.
The execution of successful HR policies does not end at the date of the transaction; they should be
regularly reviewed to ensure that the new arrangements are supporting the organisation to help to
deliver business performance.
(ii) Retaining key talent
Key talent from the target must be identified in the early stages of the M&A process, preferably during
due diligence or as soon as possible after the signing of the Term Sheet. It is customary to request the
target to have agreements in place to retain key talent for a defined period, typically for at least six
months to one year. A broader use of retention incentives can also be applied, and may take the form
of individual incentives based on individual talent and attrition risk, or a group incentive linked to
performance to support the integration effort.
(iii) Redundancy and severance
With any integration, inevitably there will be redundancies in the organisation. These redundancies need
to be handled with care, as it is an extremely sensitive topic. Assessments should be conducted to
ensure the right people are retained, and a programme should be in place to provide new opportunities
for redundant staff. For staff who are made redundant, appropriate severance packages must be
provided in accordance with local regulations. It is often invaluable to compile a headcount baseline on
closure of the deal to understand who is in the business and which function is responsible for them, and
against which to track changes throughout the integration.
Financial planning and design
(i) Finance and administration integration
In a merger, the finance function creates value by partnering with business units and provides leadership
throughout the process so that the new organisation can realise value. The challenge is in capturing the
benefits from integration without negatively impacting financial performance. Integrating finance
functions could involve redesigning and/or integrating processes, implementing shared services, and
building a strategic platform of new processes.
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Communicate face-to-face. Employees are more open and receptive to face-to-face communication.
Face- to-face communication provides the opportunity for immediate feedback from employees which
can be used to tailor future messages. This also sets the tone for how important the integration is to
senior management.
Performance culture
Communications and culture are two intrinsically linked issues and as such, they need to be managed
together. Addressing the communications needs of employees through each phase of the integration
from the onset of the official merger announcement can help address potential culture issues and
humanise the merger. Poor attention to communications and insufficient focus on addressing culture
can be very damaging to the integration.
Issue
Deal cancelled.
Communications is one of the most difficult aspects of merger integration and especially so where the
integration is cross border. The organisations management styles, culture, priorities and mindsets may
differ significantly and management decisions may not be communicated across an organisation.
Designing a change management and communications strategy that takes into consideration the culture
of the target company is important in an M&A exercise. A well-developed strategy will help minimise the
integration risk while creating an adaptive operating style for the long term.
There are four steps to gaining an understanding of the culture of the acquired organisation and
developing a plan to address it:
(i) Understand the targets current operating style. This can be achieved by administering a culture
diagnosis with leadership involvement, conducting interviews and analysing results.
(ii) Determine the future operating style of the merged organisation. It is beneficial for senior
management in the merged organisation to conduct an end-state workshop to identify long-term
strategic cultural and business objectives, and conduct an operating gap assessment.
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(iii) Develop a plan to narrow the gap. A change management plan that involves communications and
initiatives should be developed to ensure that key objectives and the intended culture can be
obtained. The new organisation should select leaders, who may or may not be managers, who are
influential within the organisation and obtain their buy-in to kick start the culture and strategy
alignment process.
(iv) Implement solutions and monitor progress. Before commencing operations integration, it is helpful
to communicate the vision and strategy of the new organisation, according to the change
management plan, to all employees. Broadly communicating the changes taking place will help to
alleviate concerns and set appropriate expectations. It also ensures that all levels of the organisation
get the same unfiltered message.
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